Managerial Economics – Tutorial – Monetary Policy

Hint: Tutorial questions are comprehensive. However, the respective lecturers should utilize
the questions based on the depth of the knowledge acquisition by students.
Essay Analytical Questions

1. Explain why even a large withdrawal of money from a commercial bank would not affect the
money supply.

2. Assume that citizens of foreign countries exchange their home currencies for American dollars
and keep the cash hidden in their homes as a means of savings. Explain what happens to the
effective size of the money supply.

3. Assume for some reason that the demand for money has risen. In addition, the Fed has responded
to this development by increasing the money supply. Explain why the movement of the interest
rate is largely indeterminate. In other words, what information are we lacking in order to make a
definitive statement about the direction of the interest rate?

4. Explain with the use of a graph why the shape of the money demand curve makes a difference
in terms of the effectiveness of monetary policy. (Hint: draw one money demand curve very steep
and another very flat)

5. Explain the effect of a reduction in the price level on the demand for money and the interest
rate.

6. Use a graph to illustrate the effect an expansionary fiscal policy will have on the money market.
What happens to the interest rate? What impact will this have on the effectiveness of fiscal policy?
7. Draw a graph of a money demand curve and a money supply curve. On the graph, indicate the
equilibrium interest rate. Also indicate the new equilibrium interest rate if the Fed increases the
money supply.

8. What do economists mean when they say that there is an "excess supply of money" in the
economy? Illustrate this situation graphically. If there is an excess supply of money, what happens
to the interest rate? How does the change in the interest rate influence the trade-off between holding
money and holding bonds?

9. Answer the following three questions dealing with monetary policy.

(a) Explain how the Federal Reserve might carry out a "tight" monetary policy.
(b) Explain how the Federal Reserve might carry out an "easy" monetary policy.
(c) How would each of the policies affect the equilibrium interest rate?

10. Assume the money market is initially in equilibrium. Now suppose there is an increase in
income. Explain what effect this increase in income will have on the equilibrium interest rate. Also
explain what the Fed would have to do if it wants to prevent this change in Y from affecting the
interest rate.

Multiple Choice Questions

1. According to the policy trilemma hypothesis, of the three goals generally pursued by
policymakers in an open economy,
A) only one of the goals is possible to achieve at any one time.
B) it is possible for a country to achieve two of the goals at the same time, but not all three.
C) it is possible for a country to achieve all three goals at the same time in the short run, but not in
the long run.
D) it is only possible for a country to achieve all three goals at the same time in the long run.

2. Which of the following increases money demand?

A) disruptions in the banking system
B) the introduction of online banking
C) the wider availability of ATMs
D) the introduction of deposit insurance

3. If an increase in the level of the money supply results in a proportionate increase in prices with
no effect on any real variables, we say that
A) the Fisher relationship holds.
B) money is neutral.
C) money is superneutral.
D) money is the most preferred store of value.

4. The money supply is vertical because

A) prices are indeterminate.
B) prices have no real impact.
C) the money supply is set by policy.
D) prices are counter-cyclical.

5. When the Fed attempts to increase real GDP and employment by ________ its target for the
federal funds rate, it is conducting ________ monetary policy.
A) raising; expansionary
B) raising; contractionary
C) lowering; expansionary
D) lowering; contractionary

6. Refer to above figure Suppose the economy is initially at full employment with real GDP equal
to potential GDP, and the expected inflation rate equal to the actual inflation rate. If the economy
then experiences a negative demand shock, the shock will cause a
A) shift from IS1 to IS2.
B) shift from MP1 to MP2.
C) shift from IS2 to IS1.
D) shift from MP2 to MP1.

7. Refer to above figure suppose the economy is initially at full employment with real GDP equal
to potential GDP, and the expected inflation rate equal to the actual inflation rate. If an economic
shock causes the IS curve to shift from IS1 to IS2, this will
A) push the economy down the Phillips curve, raising the inflation rate.
B) push the economy up the Phillips curve, raising the inflation rate.
C) push the economy down the Phillips curve, lowering the inflation rate.
D) push the economy up the Phillips curve, lowering the inflation rate.

8. Refer to above figure suppose the economy is initially at full employment with real GDP equal
to potential GDP, and the expected inflation rate equal to the actual inflation rate. If the economy
then experiences a negative demand shock, and the Fed responds to the results of the demand
shock with an appropriate monetary policy, the Fed response will result in a
A) shift from IS1 to IS2.
B) shift from MP1 to MP2.
C) shift from IS2 to IS1.
D) shift from MP2 to MP1.

9. Refer to above figure Suppose the economy is initially at full employment with real GDP equal
to potential GDP, and the expected inflation rate equal to the actual inflation rate. If the economy
then experiences a negative demand shock, and the Fed responds to the results of the demand
shock with an appropriate monetary policy, the Fed response will
A) push the economy further down the Phillips curve, lowering the inflation rate further.
B) push the economy back up the Phillips curve, raising the inflation rate towards its full-
employment level.
C) push the economy back down the Phillips curve, lowering the inflation rate towards its full-
employment level.
D) push the economy further up the Phillips curve, lowering the inflation rate further.

10. Refer to above figure suppose the economy is initially at full employment with real GDP equal
to potential GDP, and the expected inflation rate equal to the actual inflation rate. If the economy
then experiences a negative demand shock, and the Fed responds to the results of the demand
shock with an appropriate monetary policy, this would best be represented by a movement from
A) point A to point B to point C.
B) point A to point C to point B.
C) point C to point B to point A.
D) point C to point A to point B.